SD venture funding needs bolstering, despite numbers

Related Special Reports

It’s no newsflash that the San Diego entrepreneurial community is trying to put itself on the map with a no-holds-barred attempt to incubate and retain startups. But a complaint heard time and time again is that a lack of funding is restraining this movement from reaching full potential, with companies being forced to relocate north to get the financial support they need.

“We hear it a lot,” said Charles Zahl, director of the Southern California Entrepreneurial Ecosystem Development nonprofit. “Frequently, when we talk to early-stage entrepreneurs we ask them what they need, and almost inevitably their first answer is funding, more money.

“The native venture capital community in San Diego, even the general investment community, is a little bit lacking, and it got a lot smaller especially after the housing market crash, a lot of it went away.”

Yet Dow Jones’ DJX Venture Source quarterly venture capital funding report shows that the San Diego metro area is actually doing quite well in terms of capital invested, with its venture-backed companies raising essentially the same amount as those in Los Angeles, more than Orange County and Chicago, and more than the entire states of Colorado and North Carolina. If the proof is in the pudding, then what gives?

“Access to capital is always a challenge. It always has been,” said Steve Hoey, director of business creation and development at Connect San Diego. “San Diego received -- I think it’s around $587 million -- in the first three quarters of 2013.”

The DJX Venture Source numbers are slightly higher than those Hoey cited from Connect’s Q3 2013 Innovation Report, listing the San Diego metro area at $625.93 million of investment in the first three quarters of 2013. Compare that with $483.77 million in Orange County, $208.03 million for Chicago companies, $599.03 million for all of Colorado, and $264.77 million for the entire state of North Carolina.

Los Angeles spiked to $1.3 billion during this timeframe, but looking at totals from the first quarter of 2009 through the third quarter of 2013, Los Angeles claims $5.755 billion, with San Diego at $4.9 billion, a more even spread.

Boston and New York post higher numbers, and of course no other metropolis comes close to touching the San Francisco Bay Area’s amassed $54.851 billion over the nearly four-year period. Still, for a city the size of San Diego, we’re doing better than would be expected given the vocal cries about a lack of funding.

One possible reason for the discrepancy is the type of companies this money is being funneled into.

“That’s 74 companies that received funding in the first three quarters of 2013, but if you look at the number of companies that were in the seed stage, meaning as initial investment, only one such company got funded,” Hoey said based on Connect’s report.

Robert Reyes, founder of Startup Circle, elaborated on that gap in funding, saying that companies are typically able to get what he calls “Family and Friends Financing” in the very beginning, but then have a tough time crossing the bridge to larger amounts.

“San Diego companies are able to raise, not with great difficulty, anywhere from $50,000 to $150,000,” Reyes said. “It’s not easy, but they get it. But once they’re beyond $150,000, whew, they have a hell of a time getting that next investment.

“Once they’re at the point where they want to go to the next level, from north of half a million dollars to 1 million, they may want a formal Series A round, that’s where people hit the wall in San Diego. There’s not a formal stage to get that.”

Reyes said that last year, Startup Circle looked at more than 200 companies. Of those, 10 were able to secure funding over that $150,000 hurdle.

But that problem, while evident in San Diego, is not necessarily San Diego-specific.

“The challenge is that really since the recession, there has been more reticence of venture capitalists to invest in really early stage deals,” Hoey said. “One of the reasons for that was increasingly, following the recession, there was pressure on VCs to show a return to their partners, so they tended to focus what funds they had to invest in later stage companies in their portfolio. So that makes it tough if you’re a new kid on the block.”

While the incoming money metric is an important one, those in the industry stressed that you have to also consider where that money is coming from.

“One of the few downsides to the region is it’s not uncommon for VCs, when they do want to invest in an early stage company here, they look to see if the company will relocate closer to where the money is,” Zahl said. “It’s easier for the VCs to be meeting with the principal or founders and helping them along, and a lot of their contacts will be up in Bay Area so that’s creating a bit of a brain drain for the region.”

Of the 14 most active investors in San Diego in the third quarter of 2013, according to DJX Venture Source, three of the venture capital firms are headquartered or have offices in the San Diego metro area, four are in the Bay Area, three are in New York, with Chicago, St. Louis and Phoenix each with one.

DJX Venture Source tracks the flow of outgoing money based on investor headquarters, but only down to the state level. As is expected, California blows every other state out of the water, with the number of financing rounds from companies in the state almost equal to the other 49 combined. In the first three quarters of 2013, equity financing rounds for U.S. venture-backed companies with investor headquarters in California stood at 1,962, with the rest of the country claiming 2,260 rounds total.

“Most companies want VCs that really will help them with not only their capital but with their own portfolio experiences and relationships to help them grow the company,” said Don Warriner, founder and managing partner at VentureWest Partners, LLC. “Thus, having VCs in the local area is normally preferable. Many VCs will only invest in a specific location.”

Of those 10 companies Reyes mentioned that were able to get significant financing, he said two got it from here in San Diego, six from San Francisco, one from Colorado and one from Texas.

Hoey said even if relocation to be in closer proximity to the VC firm isn’t a requirement for funding, any investors that properly vet potential startups will require the company or its founders to travel to the firm to pitch, which is a time- and money-intensive venture, not to mention the added difficulty that distance brings to making contacts in the investment world. Additionally, Warriner said most VC firms are also sector-specific with virtually no generalists, which could create problems for certain types of startups.

Zahl said there has been a focus within the local entrepreneurial community on facilitating the growth of the financing element here in San Diego to eliminate those challenges posed by distance, but more can still be done.

“We really do need to help the investment community grow as people are having successful exists,” Zahl said. “What we should be doing, in my opinion, is partnering them with seasoned VCs to help them learn how to become VCs or angels so they can stay here locally.”

And finding these people shouldn’t be too difficult, as Hoey said more than 300 new companies in the innovation technology space pop up every year in San Diego. An increasing number of incubators and accelerators, including EvoNexus, Connect and its Springboard program, Johnson and Johnson’s Janssen Labs incubator, the University of California, San Diego’s Moxie Center and Startup Circle to name a few, have surfaced to help these entrepreneurs from the earliest stage through exit.

Reyes also said simply highlighting the startups with high-potential technologies would go a long way.

“What I’m pushing for is to be better at highlighting the companies we’re excited about, and having more local support from angel investors in town to highlight those companies when the next series level of investment comes in,” he said. “So what we’re doing is starting to connect with all of the different groups here in town to really create a San Diego portfolio, if you may, by sector.”

So while San Diego does rake in large amounts of VC funding, not to mention angel investment or strategic corporate partnerships -- which Hoey said is an increasingly popular option -- startup money is still a concern and hindrance in this arena.

“I think sometimes the concern is a little overblown, but we really do need to help the investment community grow,” Zahl said. “But again, there’s some really intelligent people down here, and people working on trying to help those enter by acting as mentors. There are quite a few people working on trying to increase and strengthen the investment and VC community here in San Diego, so there are definite movements on it, but it takes time.”